2015 Update

It has been a while since the last update – it is now time to consider a few things.

July 2015 - The Next 6 - 9 Months:

The market volatility is likely to be higher in the next six months to December 2015 for all the well written reasons, such as Greece / Europe and USA Interest rates, plus now a slowing Chinese economy.

I won’t go into long diatribe on each, since there has been so much written about all three.

But the big picture message is as follows – the global economy will get through all three because the various governments and Central banks could anticipate the likely outcome and make provision for the various events. The very fact that so much has been written about the issues over the past 2 years ensures that the outcomes will not be as severe as the worst case scenarios predict. So the investment markets will tread water and fluctuate in response to the various short term impacts, with the short term traders taking advantages of the market weakness.

Greece: The Eurozone has over the past 3 years reduced their debt exposure to Greece, so that a default on their loan repayments, although inevitable, will have minimal effect on the rest of Europe. Greece however, will suffer as a result and become a failed state requiring humanitarian aid. The effect on global investment markets should be zero, but a short term reaction based on emotion is likely. The recent 3rd bailout will be successful in the short term. Eventually there will be a 4th bailout and maybe finally a Grexit.

China: The Chinese share markets are NOT the Chinese economy. The crash is the result of changes to legislation in February this year (2015) that created bubble in 4 months and then popped. The share market became a casino fuelled by lending, just like the US markets in 1920’s. Only 8% of people have share accounts and although that 8% may be damaged by the crash, the other 92% are untouched. Since the 8% are the “middle class” there may be local political ramifications.

Their share market has little correlation with the economy. The small retail punter dominates the buying and selling with limited logical investment decisions – dividends are almost non existent and the short term capital gain is everything – and not subject to tax.

It is also a highly cocooned environment, so international ramifications again are minimal, if any. But some emotional reactions may unjustifiably cause ripples in overseas markets.
Australia is most likely because of our trading status with China.

While there has been a lot of noise and commentary about a China based economic meltdown – the likelihood is still low and has been predicted before with little accuracy.
The most likely outcome is a “shock” finding that the economy really only grew 4.5% instead of 7%. But – the commodity prices are already reflecting this regardless of what figure is attached to the GDP growth. The Australian economy has already been affected by the iron ore and other metals price fall. Most noticeably the W.A. economic slowdown and the Australian dollar falling against the $US.

USA Interest rate rises: The impending rate rise has been an on again off again schedule that may have been implemented in June, September or December. And get pushed back mostly as an acknowledgement that there is no inflation worth being concerned about as the underemployment amongst the casual workers, who only get 5 – 15 hours a week work is still a larger proportion of the workforce than it has been in the past and has not declined much in this recovery, so far. There is a limited inflation pressure as a result at this time and the US recovery can still continue without increase interest rates. Additionally 2 out of 3 economic indicators and reports are very positive, so the economy is on the repair and will continue to do so.

As of 17 July the reporting season so far in the US has been positive with increased revenue and profit flowing through the companies that have reported so far. So right now a September increase seems a better than 50% probability.

But for the next 6 -12 months the investment markets overall will probably be stagnant and volatile with limited growth.

By January – March the world will not have collapsed and the US recovery will be seen to still be building and lifting the global economy as a result. Recently home sales and sale values have shown a strong series of results and consumer spending has also shown reasonable growth. There still is no consumer inflation to speak of so interest rates will remain low and only creep up in small steps.

Inflation and Recoveries:

The recovery from the GFC has been incredibly weak over the past 5 years. In fact if we look at the recovery from a series of recessions in the past 50+ years what we see is that each successive recession seems to generate a weaker recovery. See the included chart here that shows the rate of recovery for each of the last 6 substantial recessions and recoveries. (There have been more complex charts also published that show more recovery patterns – but this chart is easier to see the differences, but other charts all show the same steadily weaker recoveries for each market cycle.)

The second set of 3 recoveries tracks at a slower rate than the first 3, the more recent the recession the slower the recovery in general. There are many theories about this, but the strongest correlation in the last couple of decades is the following core points:

Since world war ll each successive recovery has been based on generating consumer spending via credit – bringing forward consumption based on borrowed money. As the life cycle of items gets shorter items also have to be replaced more often. The best example is that hardly anyone keeps a car 20 years – but in the 1950′s that was almost a standard life of a car, but not now. TV’s, fridges, even whole kitchens now have a more frequent turnover rate. But while that might suit a booming economy – when things get tough it’s easier to push back replacing items until they completely give up. The recovery then takes a bit longer each time.

The ageing population at each recession move to a savings and investment phase before recommencing consumer spending. The older the age group in pre retirement the more robust the savings and investment. In Australia the pre retirees are intent on rebuilding their superannuation from the GFC. In many cases they are assisted by financial advisers that put them into strategies that focus on building super – postponing purchases and in some cases extending working years before full retirement. (In the USA and Europe they are doing the same.)As each recession impacts a larger group, as a proportion of the population, in the last 10 years before retirement the proportion of people saving and investing is larger. Additionally if they were busy consuming and not saving in their 40′s then they have much to catch up on.

Technology over 50 years has impacted cost of production and product costs. The impact of inflation is limited on many everyday items. The advent of independent central banks who target inflation and increase interest rates when really necessary has curtailed the old inflationary cycles. So now each successive interest rate decline to spur consumption and GDP growth has less of an impact because rates are now so low in an absolute sense, compared with 40 -50 years ago.

What we are seeing in this current environment since the GFC is savings and investment inflation.

The rise of investment assets, as the pre retirees funnel their “spending” into savings, negative gearing, property, shares etc. not into consumer items. And to be fair, how many TV’s and things do you need ? When everyone in the house has a smartphone and an iPad, what else do you need? The central banks feel constrained in reacting to asset inflation because the recovery has not flowed onto the point of creating jobs. So this is where the USA and Australia is at, housing prices might be going up in selected areas – and in Australia this is focused in areas where incomes are high enough that the tax advantage is significant (Sydney – Melbourne). But elsewhere it’s lacklustre, with limited prospect of significant pick up.

The valuations of the US investment (share) markets appear reasonable compared to profits and sales – with a prospect of lifting both with continued USA recovery. In general in the USA every 2 out of 3 economic reports are favourable and consumer spending is picking up along with jobs – even though it has been a slow recovery, as the charts have pointed out.In Australia the RBA has reason to be concerned about the valuations of the Sydney housing market, since it is driven by debt and the alleged shortage of property. But since the shortage may be overcome by 2017, once that may be satisfied rents will not rise to match any rise in interest rates, and the gap could be painful for over stretched investors. The 1987 – 1991 and the 2000 – 2003 property markets in saw the end of the bubble with stretched investors and limited rent growth / property value growth.

Beyond 2015 ?

The recovery in the USA has been so slow for all the reasons pointed out above that it may well continue for some time yet. Low oil / energy prices assisting the US recovery story. Rather than a boom-bust cycle the recovery may see a continued weak economic growth over another 3 – 5 years.

In some ways the weakness is the reason for it’s longevity.

Since we are now in the 6th year of recovery it will be the longest, slowest recovery probably ever recorded. This will then also tie in with the theory of the GaveKal* economic team who outlined the prospect of a longer term ongoing rise of the US S&P500.

GaveKal is an economic think tank with strong world wide reputation. They are the team that some of the top fund managers seek out for opinions when the fund managers need a second opinion.

See their chart of the possible future… expecting the USA to be driven by low energy costs, more innovation and competitively priced products.

The chart shows a repeated pattern of growth spurts after periods of extended stagnation (consolidation) in the economy and investment markets, as reflected here by the S&P500. Over next few years this would make sense – given the recent history of the past 15 years, but that would not rule out a short term ( 6 months) market correction if the markets (mostly USA) became overvalued. At this stage it does not look as this is the case.

So what would drive the economy – what new inventions and things would spur people to buy more stuff over the longer term … a few thoughts come to mind….

Solar / battery power for houses and cars. High tech electric cars like the Teslar. Leading to further cost reductions in traditional energy fuels with reduction in demand from the auto industry…

The next generation in virtual reality computer technology and applications beyond computer games.

Divining future inventions and concepts is tricky and I don’t pretend to be a futurist – but consider all the developments that were never forecasted. The internet, ipods, ipads, the mobile phone and the iphone in particular (which is effectively a handheld computer), miniaturisation, laptops; none of these show up in science fiction even 40 years ago, yet they dominate society now. And we spend a hell of a lot of money one these and the supporting software – games, apps, accessories etc.

While many people still look over their shoulder expecting another major shakeout – the reality is that maybe there won’t be one. Although, as interest rates around the world creep back to some delicately poised higher level, we could see a slower growth in a “dribble up” effect with periods of stagnation, and various market drops when there is no good news momentum.